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The UK option: An advanced UK–EU Free Trade Agreement, while addressing some of the costs of EU
membership, would fail to secure vital benefits for business

Each of the previous options provides useful lessons about the alternatives other
countries have chosen for their relationship with the EU. All of them have
significant drawbacks and do not provide the relationship with the EU that the UK –
the world’s sixth-largest economy – requires in order to pursue its global trade
ambitions. Were the UK to leave the EU, it is not likely to adopt an off-the-peg
solution; rather, it would negotiate a bespoke relationship with the EU, reflecting
its unique economy. The final option that should be considered is therefore a ‘UK
option’ seeking to keep a relationship with the EU through an ambitious UK–EU Free
Trade Agreement.

It is possible to set out a ‘best-case’ scenario if the UK were to leave the EU,
incorporating the best aspects of all the alternative models, and analyse what would
be possible to achieve and whether this would be better for British business than
the type of relationship the UK currently has with the EU.

Advocates argue that, rather than replicate existing models – after all, the UK is
not Norway, Switzerland or Turkey – the UK should be seeking its own unique deal,
one that suits British business for jobs, growth and trade by repatriating UK
competence on regulatory issues from Brussels while at the same time preserving the
benefits of EU membership in terms of market access. The argument runs that the UK
is more than capable of negotiating a bespoke deal that maintains market access
without the membership fee.

Given the high level of economic integration between the UK and Europe, which has
deepened since the UK joined the EU, as well as the importance of intra-industry and
regional trade for reasons explained in Chapters 1 and 2, the UK is highly likely to
secure a Free Trade Agreement with the EU, and such an agreement would be likely to
be negotiated at an extremely high level of ambition relative to other FTAs.

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The EU is not likely to give any country a deal that in practice is better
than EU membership with all the advantages and none of the costs.

However, negotiations would not be like any other trade negotiation: the UK would be
trying to strike a deal with the very organisation it had just exited. Unusually,
the ambition for negotiators would be to protect the level of openness that the UK
and EU already share, rather than seeking to break down existing trade barriers.
Whether negotiators would be successful in doing that would rely on the nature of UK
withdrawal from the EU. A withdrawal could be constructive and diplomatic, but it is
more likely that some level of political fallout could be expected among EU leaders
and, even if dealt with diplomatically in public, this could easily be felt at the
negotiating table. Poland’s Foreign Minister Radek Sikorski argued in The Times: “If
you believe Britain could negotiate a trade deal that preserved all the advantages
of the Single Market without any of the costs of membership. Don’t count on it. Many
states would hold a grudge against a country that had, in their view, selfishly left
the EU”.[54]

Nevertheless, looking at the long-term and factoring in the likelihood of political
fallout from a British withdrawal, it can be assumed that the UK and EU would seek
to negotiate some sort of Free Trade Agreement, given the economic importance of
securing such an agreement for both the UK and, to a lesser extent, the EU. However,
as Sikorski implies, the EU is not likely to give any country a deal that in
practice is better than EU membership with all the advantages and none of the costs.
That would undermine the very existence of the EU and could provide an economic
incentive for other members to consider withdrawal options as well.

Chapter 3 detailed how the EU’s size and clout makes it better positioned than the UK
to sign deep and ambitious FTAs with third countries. The same argument would apply
were the EU negotiating with the UK regarding a bilateral FTA and there are a number
of factors that give the EU a stronger negotiating hand in any future trade talks
between the two parties:

The EU28 (excluding the UK) has a 445 million market, compared to the UK’s 63
million, while its economy is almost seven times the size of the UK’s.[55]

The UK is more dependent on the EU for its trade than the EU is on the UK.
Around half of the UK’s total trade is with the EU, while just 8% of EU trade is
with the UK.[56] The fact that
the UK happens to run a deficit in exports with the rest
of the EU is much less relevant in terms of which economy is more dependent on the
other than the relative proportion of total trade for each.

The open-market, free trading philosophy in the UK would likely lead to a
default position on exit of low tariffs for all its trading partners (its
WTO ‘Most Favoured Nation’ (MFN) bound and applied tariff rates). This would mean
that, during UK–EU FTA negotiations, the EU may not feel pressured into lowering its
own tariffs towards UK business, because it could (reasonably) assume that the UK
would – no matter what the terms of the UK–EU FTA – pursue a unilateral open-market
policy to all trading partners, including the EU.

Tariff-free access for the UK in goods and services would not be
straightforward

A key demand from British business with a UK–EU FTA would be to retain market access
to Europe. For goods trade, most FTAs, particularly those negotiated by the EU,
substantially decrease or eliminate tariffs, and so a UK–EU FTA could be expected to
also include such measures. However, while a zero tariff on all UK–EU goods trade
would be the optimal outcome for business protecting the existing level of market
access for UK goods to the EU and vice versa, this could not be guaranteed, and it
should be noted that all EU FTAs, even the most ambitious such as EU-Korea, include
exceptions from full tariff elimination and therefore do not provide complete
coverage.

As a result, simply to achieve duty-free access in an FTA between the UK and the EU,
something that many people assume would be a given, may not be straightforward and
would actually set a new gold standard that has not been fully replicated by any EU
FTA partner, or by Norway, Switzerland or Turkey in their respective models. Even in
Turkey, where a customs union with the EU is in effect, agricultural goods are not
included within the scope. Furthermore, following UK exit from the Single Market, UK
goods exports would be met with increased border bureaucracy and, as with the Norway
and Swiss options, burdensome rules of origin would be necessary.

For market access in services, it would be in the UK’s interest to secure a very
ambitious agreement to ensure minimal disruption to services providers across all
sectors, building on the WTO GATS framework. However, services trade negotiations
are extremely complex, because the provision of services exports not only relies on
the ability of a company to provide a service ‘cross-border’ from a base in the UK
(e.g. to provide legal advice via phone or email) but can also rely on the ability
of a service provider to set up an office overseas (Mode 3 – establishment overseas)
or to ensure that its staff can physically move across borders (Mode 4 – temporary
movement of persons).

In order to preserve the same benefits as the UK currently gets from EU membership in
terms of services trade, noting in particular the freedom to provide cross-border
services as set out in Article 56 of the Treaty on the Functioning of the European
Union (TFEU) and the freedom of establishment in Article 49 of the same Treaty, as
well as the 2006 Services Directive and the ECJ’s role in enforcing the directive,
the UK and EU would have to negotiate an FTA that goes way beyond any other EU FTA
that has been negotiated to date. While such an FTA may set a world standard
globally, with – in a best-case scenario – more sectors fully covered under ‘right
of establishment’ and longer permissible temporary movement of persons than seen
before in other FTAs, this would still represent a severe deterioration from the
status quo, even accounting for the incomplete nature of the current internal market
for services.

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The UK would no longer be in a position of strength in FTA
negotiations with key trading partners.

Furthermore, there could be practical restraints that prevent the EU from agreeing to
such a high level of ambition, even if this was the desired outcome. For example, in
the EU–Korea FTA, there are clear provisions implying that, were the EU to negotiate
more ambitious commitments on trade in services with another FTA partner, those
benefits would have to apply to Korea as well (unless as part of a regional
agreement). Consequently, even if the EU was to agree to very ambitious FTA
commitments on trade in services with the UK, it would have to open up these
benefits to its other FTA partners as well, which could present problems for the EU,
especially given that the pro-free trade voice inside the EU itself would have been
weakened considerably following the UK’s departure from the EU. To avoid this, the
EU could adopt an approach whereby it offers the UK the same terms as its model FTA
partners, which cannot be compared to the current internal market for services.

Securing full market access requires regulatory convergence

The ‘going it alone’ WTO option clearly highlighted how the potential creation of new
non-tariff barriers would be a major concern if the UK was to leave the EU, and a
key focus of a UK–EU FTA would be to minimise future regulatory divergence on issues
that can be closely linked to trade (as opposed to EU employment law, for example).
With the EU responsible for nearly half of UK exports, the last thing that UK
companies want is to produce a good or provide a service that meets UK regulatory
requirements, but not EU requirements.

To avoid this from happening on many key regulatory issues, there is a huge risk that
the UK would get pushed into being a ‘standards taker’, forced to align its own
regulatory standards with the EU on issues such as safety standards and
environmental regulations, yet would lose influence over how the EU rules are set
without a say in the EU Council, Commission or Parliament.

There are provisions in other EU FTAs backed up by dispute settlement procedures that
do seek to prevent new NTBs from arising. In modern EU FTAs, action to reduce
existing NTBs that constitute a major trade barrier with a third party are
increasingly important for the overall success of negotiations (the ongoing EU–US
and EU–Japan negotiations are set to be major examples of this). However,
commitments made on NTBs between two parties cannot be compared to the common laws
and standards that exist inside the EU. The EU would not be likely to open its
borders for British goods and services unless these standards were deemed to fulfil
rules of equivalence, which could be established in three ways:

Following EU rules: The UK could continue to voluntarily adopt EU
rules as they are outlined by the EU. This would mean that any regulatory burden
would remain as if the UK were still a member, as happens to Norway.

A system of equivalence: The UK might be able to negotiate a system
where the EU would acknowledge UK national laws as equivalent to its own. Such a
regime – in principle the same as the EU’s own principle of mutual recognition –
would, of course, have to be constantly updated as EU law changes. If a UK regime
was thought outdated, market access would be at stake until the UK could
satisfactory prove equivalence was restored. This system would, however, mean that
the final decision of whether UK rules are ‘equivalent’ would be up to the EU and
could therefore fall victim to politically motivated assessments.

A system of independent authorities: The UK and the EU could set up
independent authorities similar to that of the EEA to authorise and monitor whether
the UK’s regime is equivalent. This would take some of the powers away from the EU,
but an independent body would be likely to involve costs. Moreover, for the EU to
trust the body, it would have to be empowered with enough resources and powers to
keep the UK’s regulatory development in line with the EU’s. In this scenario, the UK
would find itself supervised by another body, which would not address the concerns
of those arguing that leaving the EU would give the UK more power to set its own
rules.

The UK would have an independent trade policy but suffer dislocation of market
access as it negotiated many new agreements simultaneously, with no guarantee of
securing market access on favourable terms

As with the Norway, Swiss and WTO options, being outside the EU would enable the UK
to pursue its own external trade agenda, with the potential opportunities, risks and
limitations that this entails. The UK would be able to pursue its own FTA
negotiations with the trading partners it chooses, and could take forward its own
strategy, factoring in its historic ties and long-term economic interests.

However, there remains an open question as to what would happen to EU FTAs with other third countries that are currently applied to UK businesses. At some point, perhaps after a short transitional period, these FTAs would have to be renegotiated, and the uncertainty around this issue is a key cause for concern for many exporting businesses. It would take time for the UK to first regrow the capability
to negotiate FTAs and there would be a period of dislocation – perhaps for many years – while new UK bilateral deals were finalised.

PIn addition, the UK would no longer be in a position
of strength in negotiations with key trading partners. Depending on the commitments it takes at the
WTO on a multitude of trade issues (for example, the applied and bound MFN tariff rates it sets, its commitments under GATS and the GPA), the UK would not necessarily have much to ‘trade off’
in a negotiation, which could make the practical feasibility of concluding negotiations to get the best result for Britain increasingly difficult. Furthermore, the UK would become one of nearly 200 other WTO members when pushing its issues on the multilateral agenda and when defending its borders from trading practices by third countries that were inconsistent with WTO rules: its influence on global trade and related economic matters on the international stage would inevitably decline.

Investment is likely to drop, even with a deep Free Trade Agreement, and the impact
on the UK’s financial services sector would be significant

In the event of a British exit, investment and capital flows would be likely to be
disrupted as the legal basis for the UK investing in the EU, and vice versa, would
change. Article 49 of the TFEU on the freedom of establishment would cease to apply,
and the UK would need to secure new commitments protecting the ability for UK
companies to invest in the EU with legal certainty, across all sectors.

Typically, EU FTAs do include provisions on capital movement – for instance to ensure
that payment operations remain unrestricted and that transactions related to direct
investment remain free of restrictions – although there are also clauses allowing
for time-limited safeguard measures in case of serious difficulties for the
operation of monetary and exchange rate policy.

48% vs 8%

Percentage of exports for the UK and EU respectively
dependent on the other

A major concern, however, is that, even with a very ambitious UK–EU FTA that
incorporated the above commitments and very ambitious provisions on ‘right of
establishment’ to permit UK companies to attain the same equity stakes in other
European companies as is possible today (and vice versa), there could still be a net
capital outflow in this scenario, with overseas investors preferring to relocate
their activities within the EU trading bloc.

It is possible that the City could remain as an offshore capital market for some EU
companies. However it is more likely that, over time, rival capital markets inside
the currency area would emerge and there would be political pressure following UK
withdrawal from the EU in this direction to restrict EU dependence on the UK.